The era of small government is over. Regulation is back. Governments now control finance.
Amid all the mind-boggling developments of the past two weeks, however, perhaps the greatest is this: government is going global.
Initially, the financial crisis that followed the bankruptcy of Lehman Brothers appeared confined to the United States. Within days, however, it had spread to Europe. Haltingly, governments on both sides of the Atlantic began to develop national plans to shore up their banks and unfreeze their lending. Ten years ago, such national solutions would probably have sufficed. But when they were rolled out ten days ago, they fizzled almost instantly, partly because they failed to inject enough capital into a tottering financial system, but also because their scope was merely national, while the economy they sought to save had grown so global that national solutions no longer sufficed.
In Europe, a continental economy had emerged, but there was no truly effective continental government to set its rules. When the crisis hit, some nations guaranteed all their bank deposits while others did not -- creating the prospect that depositors could take their euros and put them in the nation next-door. At the same time, some banks whose operations were spread over several nations were failing, and it wasn't clear which European nations where such banks had branches should bail them out, and to what extent, and under whose authority.
But even before the crisis hit, the mismatch between global corporations and national governments was undermining the stability of the system. Consider, for instance, the failure and de facto nationalization of AIG -- a corporation of by-the-book U.S.-based insurance companies undone by all the credit default swaps engineered by its London-based financial products unit. Congress had decided in 2000 to exempt those swaps from regulation, but that's only part of the story, since some of the unit's activities were subject to governmental oversight. Though the unit was based in London, however, it was regulated by the U.S. Office of Thrift Supervision, since AIG owned a savings and loan back in the states, and by French banking regulators, since AIG owned a bank in France.
If that sounds both Byzantine and ineffectual -- well, it was. It's also emblematic, however, of the growing disjuncture between national jurisdictions and a world economy. China now provides much of the world with food, medical and industrial products, though its product safety record doesn't inspire much confidence. U.S.-based airlines perform maintenance work on their planes in Central America, where labor is cheaper and safety inspections from U.S officials are infrequent.
But it took the collapse of finance to force governments to confront the limits of national power. Last weekend, the nations of Europe realized that they all had to embrace the identical recapitalization and deposit-insurance plan (devised by British Prime Minister Gordon Brown) to restore confidence in the financial sector. By so doing, they set a safety standard that the U.S., despite the ideological reluctance of the Bush Administration, was compelled to adopt as well.
This epochal transition should come as no surprise to Americans, because it echoes this nation's experience in the 1930s. Before the New Deal, government in America was handled chiefly at the level of the individual states, which chartered and oversaw banks and corporations. In the banking crisis of 1932-33, a number of governors ordered their states' banks to close to prevent bank runs, but these closures did nothing to restore the public's confidence. Only when FDR became president and ordered a national bank "holiday" and inspection did the bank runs cease. The New Deal not only subjected what had been a laissez faire economy to governmental regulation, but it shifted the functions of government from the states, which had been unable to manage an economy that had morphed from local to national over the preceding 70 years, to Washington.
Now, emboldened by the provisional success of their cross-border coordination, Brown, French President Nicholas Sarkozy and other European leaders are calling for the convening of a global conference to create some global rules of the road -- a Bretton Woods 2.0. Prompted by the continuing financial instability, the Europeans want to get started next month -- though if they want the American people to buy into a new planetary level of governance, they need to wait until the United States can be represented by an administration with more popular support and legitimacy than Bush's.
More fundamentally, though, the authors of the new global compacts must do more than write the rules and establish the transnational institutions to regulate 21st-century finance. They need to put rules and regulators in place to ensure the safety of the products the global economy creates, and the safety and living standards of the workers who produce them. It's time to globalize the New Deal.